Yuan-denominated Trade Settlement andthe Internationalization of China’s Currency
Eiichi Sekine
Senior Analyst,
Nomura Institute of Capital Markets Research

I.

Settling trade in yuan: background and history

1. Sharp drop in exports
After the global financial crisis triggered by subprime loan problems in the US
deepened and led to the failure of Lehman Brothers in September 2008, economies
around the world slowed down, and consumer markets also contracted. Consequently,
China's export performance, both in absolute value and percentage growth terms,
worsened substantially from late 2008 until early 2009 (Figure 1). At the same time,
corporate earnings deteriorated, especially those of smaller firms involved in China's
processing and assembly exports, and the unemployment rate rose.

Figure 1: China's trade since 2008

2008

1

Import value (lhs)

YoY growth in exports (rhs)

YoY growth in imports (rhs)

Jan

Nov

Dec

Oct

Sep

Aug

Jul

2009

Export value (lhs)

Source:

Jun

May

-60
Apr

0
Mar

-40
Feb

-20

20
Jan

40

Dec

0

Oct

60

Nov

20

Sep

80

Jul

40

Aug

60

100

Jun

120

May

80

Apr

140

Mar

100

Feb

（％）

Jan

（US$ billions）
160

2010

Trade surplus (lhs)

Nomura Institute of Capital Markets Research, based on data from Wind
Information and CEIC

Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

The Chinese government responded to this in November 2008 with a RMB4
trillion stimulus package to encourage growth in domestic demand, and also initiatedprograms to support exporters. These programs ran the gamut from tax breaks (anincrease in the export VAT refund rate) to financial incentives (using the China Export
Import Bank and the China Export & Credit Insurance Corp.) and employer incentives(via revisions to minimum wage rules). Introducing a mechanism for settling trade inyuan to help exporters avoid currency risk was also considered. There has long beeninterest in allowing trade, which in mainland China has always been settled in aforeign currency, to be settled in yuan from the prospective of internationalizing
China's currency.

2. The road leading to yuan-denominated trade settlement
A pilot program for yuan-denominated trade between the mainland and Hong Kong
was launched on 6 July 2009. A concise summary of the policy changes that led tothat program being started follows (Figure 2).
The economic and trade relationship between the mainland and Hong Kong
became substantially closer in June 2003 with their signing of the Closer Economic
Partnership Arrangement (CEPA), a program initially aimed at kick starting a Hong
Kong economy damaged by the SARS epidemic. Efforts by the mainland to help
Hong Kong's economy included aggressively promoting Hong Kong to mainland
tourists, and this required supporting the circulation of yuan in Hong Kong. To thisend, the ban on Hong Kong banks accepting yuan-denominated deposits (including
both money exchange and transfers) was lifted in January 2004, while the restriction
against corporate yuan-denominated deposits was removed for seven targeted industry
sectors (retail, dining and drinking, lodging, transportation, telecom, healthcare, andeducation) in October 2005. In addition, the restriction against mainland China
financial institutions issuing yuan-denominated bonds in Hong Kong was lifted inJuly 2007. Subsequently, this lifting of the restriction was extended to more issuers,
including the mainland China subsidiaries of foreign-capitalized financial institutions
and China's Ministry of Finance, the issuer of Chinese government bonds (CGBs).
These changes have led to the gradual development of an offshore yuan market inHong Kong.
With the earnings of China's exporters seriously affected by the financial crisis
starting in 2008, the General Office of the State Council (equivalent to Japan's
Cabinet Secretariat) released on 8 December 2008 its Opinions Regarding the Current
Use of Financing to Spur Economic Development. Also known as the Thirty Opinions
on Financing, this included provisions to support the development of yuan-based
services in Hong Kong and the denomination of trade with China's neighboring
countries in yuan.

Yuan-denominated trade settlement and the internationalization of China’s currency

2

Figure 2: Policy events leading up to yuan trade settlement
Date

Details
June 2003 China and Hong Kong sign the Closer Economic Partnership Arrangement (CEPA).

September 2003 The State Administration of Foreign Exchange (SAFE) promulgates on 22 September, andimplements on 1 October, the Measures for Administration of Border-trade Foreign Exchange Matters.
January 2004 Prohibition against Hong Kong banks accepting yuan deposits (including money exchange andremittances) is lifted.
October 2005 Prohibition against yuan deposits for seven targeted industries (retail, dining and drinking, lodging,transportation, telecom, healthcare, and education) is lifted.
October 2005 Restriction against issuance by international development institutions of Panda bonds (yuan-

denominated bonds issued by nonresident entities) is lifted, and the International Finance Corporation(IFC) and Asian Development Bank issue their first such bonds.
July 2007 Restriction against the issuance by mainland banks of yuan-denominated bonds in Hong Kong islifted, and the China Development Bank issues its first such bond.
December 2008 The Opinions Regarding the Current Use of Financing to Spur Economic Development (Thirty Opinions
on Financing) issued by the State Council on 8 December includes the concept of testing yuandenominated trade settlement.
December 2008 The PBC and Bank of Korea sign a bilateral currency swap agreement for RMB180 billion on 12
December.
December 2008 In its Opinion on the Maintenance of Stable Growth in Foreign Trade, the State Council decided to test
yuan settlement for trade between Guangdong province and the Yangtze Delta region (Shanghai city,
Jiangsu province, and Zhejiang province) and Hong Kong and Macao, as well as for trade between the
Guangxi Zhuangzu Autonomous Region and ASEAN.
January 2009 The PBC and Hong Kong Monetary Authority sign a currency swap agreement for RMB200 billion on
20 January, and the PBC subsequently signs bilateral currency swap agreements with four othercentral banks.
January 2009 The State Council selects five cities in China as pilot cities for yuan trade settlement, Shanghai andfour cities in Guangzhou: Guangdong, Shenzhen, Zhuhai, and Dongguang.
April 2009 The State Council publishes opinions on Shanghai's international financial center and global shipping
hub on 14 April.
May 2009 On 8 May, the Shanghai City government reaffirms the concept of cross-border yuan payments andsettlements related to yuan-priced traded contained in the State Council's opinion on Shanghai'sinternational financial center.
June 2009 The China subsidiaries of the Bank of East Asia and HSBC issue yuan denominated bonds in Hong
Kong.
June 2009 On 29 June, the PBC and HKMA signed a memorandum of understanding to test yuan-denominatedtrade settlement.
July 2009 On 2 July 2009, the PBC, Ministry of Finance, Ministry of Commerce, General Administration ofCustoms, State Administration of Taxation, and China Banking Regulatory Commission (CBRC)
jointly promulgated, and implemented the same day, the Administrative Rules on Pilot Program ofRenminbi Settlement of Cross-border Trade Transactions. They also published a Q&A for those
Administrative Rules.
July 2009 On 3 July, the PBC promulgated, and implemented the same day, the Regulations for Implementing
the Administrative Rules on Pilot Program of Renminbi Settlement of Cross-border Trade
Transactions.
July 2009 On 6 July, China and Hong Kong begin yuan-denominated trade settlement.
July 2009 On 8 July, Mizuho Corporate Bank announces it will provide various services related to yuandenominated trade settlement in Hong Kong. On 6 July, Mizuho Corporate Bank's Hong Kong branchsigned an agreement with the Bank of China's Shanghai Branch to open an account for settling tradein yuan. Japan's other two megabanks obtained the same license on different dates.
July 2009 On 28 July, the Philippine Central Bank and the Bank of China's Manila branch signed an agreement
to buy and sell yuan cash, and send yuan transfers, thereby authorizing the Bank of China to provide
yuan services within the Philippines. It began offering these services on 31 July.
August 2009 On 17 August, the State Council approved its Opinions Regarding Further Implementation of theStrategy for Revitalization of Old Industrial Bases in the Northeast and Elsewhere. The nine areas ofreform and opening in this opinion supports the promotion of yuan trade settlement in the Northeasternregion of Liaoning, Jilin, Heilongjiang, and the Inner Mongolia autonomous region.
September 2009 On 8 September, the Chinese government announced plans to issue RMB6 billion of yuandenominated government bonds in Hong Kong, with actual issuance on 27 October.

Source:3

Nomura Institute of Capital Markets Research, based on data from People's Bank of
China and various other sources

Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

Then on 24 December 2008, the Standing Committee of the State Council decided
to introduce a pilot program for yuan-denominated settlement for trade between
Guangdong province and the Yangtze Delta region (Shanghai city, Jiangsu province,
and Zhejiang province) and Hong Kong and Macao, as well as for trade between the
Guangxi Zhuangzu Autonomous Region and ASEAN countries. These were the areas
in China where exporting industries were hardest hit by the global economic
slowdown. On 20 January 2009, the People's Bank of China (PBC) and the Hong
Kong Monetary Authority (HKMA) signed a RMB200 billion (HKD227 billion)
currency swap agreement.
China then accelerated its preparatory moves in April 2009. On 8 April 2009, theStanding committee of the State Council (equivalent to the Cabinet in Japan) named
five regions within China for the pilot program: Shanghai, as well as four cities in
Guangdong province: Guangzhou, Shenzhen, Zhuhai, and Dongguang. Shanghai's
global financial center concept also refers to yuan trade settlement. On 29 June 2009,
the PBC and HKMA signed a memorandum of understanding to test the settlement oftrade in yuan.
On 2 July 2009, the PBC, Ministry of Finance, Ministry of Commerce, General
Administration of Customs, State Administration of Taxation, and China Banking
Regulatory Commission (CBRC) jointly promulgated, and implemented the same day,the Administrative Rules on Pilot Program of Renminbi Settlement of Cross-border
Trade Transactions, and also published a Q&A for those Administrative Rules. The
next day, on 3 July, the PBC promulgated, and implemented the Regulations for
Implementing the Administrative Rules on Pilot Program of Renminbi Settlement of
Cross-border Trade Transactions.

II. Yuan-denominated trade settlement schemes
1. Two settlement methods
China's main form of trade is processing and assembly trade, whereby it imports
components and materials, processes and assemble those inputs in China, and thenexports intermediate or final products. Intermediate and final goods have a higher
value added than do the inputs, of course. In terms of the processing and assembly
cycle for a single product, the amount paid for imports is exceeded by the amountreceived for exports.
Hong Kong is an entrepot, intermediating trade between China and other countries
and regions. Using the same single-product processing and assembly cycle example, if
Hong Kong settles its trade in yuan, the value of its exports to the mainland isexceeded by the value of its imports from the mainland. For Hong Kong to be able toprocure additional yuan over what it has already received for exports to the mainland
in order to pay for the imports, it is critical that a mechanism be built to allow Hong
Kong banks to procure enough yuan to cover the difference.

Yuan-denominated trade settlement and the internationalization of China’s currency

4

The cross-border clearance and settlement of yuan funds associated with the yuan
trade launched in July 2009 could either be done through a clearing bank in Hong
Kong or Macau or through a domestic correspondent bank representing a participating
overseas bank. Either approach would provide a channel for procuring yuan (Figure 3).

Figure 3: Yuan-denominated trade settlement schemes
Yuan currency swaps(Supply short-term liquidity, promote trade)(Mainland)(Hong Kong)
Hong Kong Monetary
Authority

Peoples' Bank of China

Domestic agent (correspondent) bank
Settlement

Able tosupply yuan

Clearing bank (Bank of China (Hong Kong))
Settlement

Money exchange and accountlending for guarantee funds

Domestic settlement bankOverseas participating bank

Individuals(Hong Kong
residents)

Corporations(7 designatedindustries)

RMBdenominateddeposits

Settlement
Settlement

Settlement
Exports to Hong Kong
Exporter

Importer
Yuan

Pilot
enterprise

Investment

Exports to mainland
Importer

Exporter
Yuan

Ministry of Finance
Mainland financial institution
Foreign financial institution

Source:

RMB-denominated bonds in Hong Kong
Bonds issuance

Nomura Institute of Capital Markets Research, based on data from People's Bankof China

2. Settlement mechanism
1）If through a domestic correspondent bank
The relationship between the domestic correspondent bank and the participating
overseas bank or domestic settlement bank is as follows.

5•

The domestic correspondent bank signs a yuan settlement agent agreementwith the participating overseas bank and opens a yuan nostro (correspondent)
account.

•

The domestic correspondent bank can demand funds to guarantee the yuan
nostro account and provide money exchange services for the guarantee funds.

•

The domestic correspondent bank can buy and sell yuan within limits asrequested by the participating overseas bank. Those limits are set by the PBC.

Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

•The domestic correspondent bank can provide account financing to theparticipating overseas bank. The loans would be for meeting the needs of
temporary account positions, and the PBC determines the maximum loan
amount and loan period.

•

The domestic correspondent bank can also provide yuan settlement services as
the domestic settlement bank. The domestic settlement bank provides yuan
settlement services with pilot firms.

2）If through a clearing bank
The relationship between the clearing bank and the domestic settlement bank is asfollows.
•

Commercial banks that have already been approved by both the PBC andmonetary authorities in Hong Kong and Macau to participate in the PBC'slarge-value payments system and that offer yuan clearing services in Hong
Kong and Macau are referred to as the Hong Kong and Macau yuan clearing
banks. Currently, the yuan clearing bank in Hong Kong is the Bank of China(Hong Kong) and the clearing bank in Macau is the Bank of China (Macau).

•

The Hong Kong and Macau yuan clearing banks have been approved by the
PBC Shanghai Branch to participate in the mainland's nationwide interbank
market. The clearing banks can exchange yuan and procure yuan funds using
the mainland's interbank foreign exchange market and interbank market.

3）Yuan currency swaps
In addition to the regular settlement services noted above, China has signed acurrency swap agreement with Hong Kong. This creates a mechanism to supply
commercial entities in Hong Kong with the yuan they need for trade settlement.
Including Hong Kong, the PBC has signed currency swap agreements with six
different countries/regions for a total of RMB650 billion (Figure 4).

3. The selection of pilot enterprises
The provincial-level governments in the pilot regions (the governments ofGuangdong province, Shenzhen city, and Shanghai city) work together with therelevant governmental departments for those regions to recommend pilot enterprises.
The PBC, in cooperation with the Ministry of Finance, Ministry of Commerce,
General Administration of Customs, the State Administration of Taxation, the CBRC,
and other relevant entities, examines the candidates and selects the pilot enterprises.
There is no specific licensing required for the overseas counterparty.

Yuan-denominated trade settlement and the internationalization of China’s currency

6

Figure 4: Countries with currency swap agreements with China
Country/
regionName of central bank

Date of agreement

Amount(RMB billions)

Term

Amount in other currency

Korea

Bank of Korea

12 December 2008

180 3 years 38 trillion won

Hong Kong

Hong Kong Monetary
Authority (HKMA)

20 January 2009

200 3 years 227 billion HK dollars

Malaysia

Bank Negara Malaysia

8 February 2009

80 3 years 40 billion Malaysian ringgit

Belarus

National Bank of the Republic
11 March 2009of Belarus

20 3 years 8 trillion Belarusian rubles

Indonesia

Bank Indonesia

23 March 2009

100 3 years 175 trillion Indonesian rupiah

Argentina
Total

Central Bank of Argentina

2 April 2009

70 3 years 38 billion Argentine pesos
650

Source:Purpose of agreement
・Support short-term liquidity
・Settle trade
・Supplement the Chiang Mai Initiative(CMI)
・Considering mutually holding theother currency as a reserve currency
・Support short-term liquidity
・Settle trade
・Settle trade
・Settle investment
・Settle trade
・Settle investment
・Support short-term liquidity
・Settle trade
・Settle investment
・None noted

Nomura Institute of Capital Markets Research, based on data from People's Bankof China

The examination criteria include whether the enterprise has ample experience withinternational settlement, has strictly complied with regulations established by the
Ministry of Finance, Ministry of Commerce, General Administration of Customs, andState Administration of Foreign Exchange (SAFE), and has strong credit. The pilot
enterprise must choose one domestic settlement bank as its primary reporting bank.
The first group selected for the test numbered 365 firms (182 of them foreign),
including 92 (27) in Shanghai, 88 (41) in Guangzhou, 56 (38) in Dongguang, 38 (18)in Zhuhai, and 91 (58) in Shenzhen. Ten of the firms selected are Japanese. Most of
the pilot enterprises (258) are manufacturers, and the second most (78) are in thewholesale/retail trade (Figures 5 and 6).

Figure 5: Japanese firms selected as pilot enterprises for yuan trade settlement
Shanghai

Shenzhen

DongguangCompany

Parent company

Shanghai Mitsubishi Elevator

Mitsubishi Electric

Mitsubishi Electric Shanghai Electric Elevator

Mitsubishi ElectricFuji Xerox of Shanghai

Fuji Xerox

Ricoh Components Asia (Shenzhen)

Ricoh

Ricoh Elemex (Shenzhen)

Ricoh Elemex

YKK Zipper (Shenzhen)

YKK

Toshiba Tec Information Systems (Shenzhen)

Toshiba Tec

Epson Engineering (Shenzhen)

Seiko Epson

Omron Electronic Components (Shenzhen)

Omron

Konica Minolta Business Technologies(Dongguang)

Konica Minolta Business Technologies

Source: Nomura Institute of Capital Markets Research, based on various data sources

7

Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

Figure 6: Industry sectors of the pilot enterprises selected
for yuan trade settlement

Other, 30(No. of firms)

Wholesalers/retailers, 78

Manufacturers, 258

Source:Nomura Institute of Capital Markets Research, based on various data
sources

4. Supervision and monitoring
There are a number of regulations in place to enable the supervision andmonitoring of the yuan inflows and outflows (particularly outflows from themainland) that will result from the introduction of yuan trade settlement. We list themain regulations below, but bear in mind that there are other regulations in addition tothese.

1) Regulations on pilot enterprises and bank obligations•

The pilot enterprise shall create a yuan settlement ledger (administered by thePBC) and accurately record information on import/export customs declarations
and yuan fund payments and receipts. (Article 14 of the Implementing
Regulations)•

When applying for yuan settlement, the pilot enterprise shall inform thedomestic settlement bank of the date or scheduled date of import/export
customs clearance and information on the actual transaction, fill out truthfully
the standard forms (Notes for Receiving Renminbi from Export Transactions
and the Notes for Paying Renminbi to Settle Import Transactions), andotherwise help the domestic settlement bank examine the authenticity andconsistency of the trade documents. (Article 14 of the Implementing
Regulations; separate rules apply for advance receipt and advance payment(shall present documentation of trade agreement when 25% or more of thetotal amount) and for processed trade where the customer supplies the inputs.)

Yuan-denominated trade settlement and the internationalization of China’s currency8•The pilot firm can keep yuan export proceeds outside of China, but shall file areport, via the domestic settlement bank, with the local office of the PBC.
(Article 23 of the Administrative Rules)

A pilot enterprise that has not recovered the related yuan proceeds 210 days after
exporting the related goods shall, via its domestic settlement bank, report within fiveworking days the outstanding amount and the serial number of the corresponding
export declaration form to the Cross-border Renminbi Receipt and Payment
Information Management System, and shall provide relevant documents to its
domestic settlement bank. (Article 23 of the Administrative Rules)

2) Rules on obtaining yuan financing
The total outstanding financing provided by a domestic correspondent bank foroverseas participating banks shall not exceed 1% of the domestic bank’s total yuan
deposits outstanding at the end of the previous year, and the term of the financing
shall not exceed one month. The PBC may modify this rule based on the situation,
however. The local PBC office with jurisdiction supervises the account financing
activities of the domestic correspondent bank. (Article 7 of the Implementing
Regulations)•

A clearing bank's outstanding borrowing and lending amount on thenationwide interbank market shall not exceed 8% of the bank’s outstanding
yuan deposits at the end of the previous year, and the term of the loans shallnot exceed three months. (Article 11 of the Implementing Regulations)•

A domestic settlement bank may provide yuan trade finance to an overseas
firm. The amount of that financing cannot exceed the amount of the tradecontract between the pilot enterprise and the overseas firm.(Article 13 of the
Implementing Regulations)III. Results and issues thus far
1. Yuan-denominated trade totaled RMB3.58 billion in 2009
How much trade was actually settled in yuan in 2009?
The China Monetary Policy Report for Q4 2009, released by the PBC on 11
February 2010, states that 409 trade transactions worth RMB3.58 billion were settled
in yuan in 20091. The Q3 2009 report, dated 11 November 2009, stated that yuan tradefrom 6 July until 30 September totaled RMB100 million. Such trade has thus shownstrong growth since October 2009.

1

This report is reprinted from Vol. 3-4 2010 of China Capital Markets Research (inJapanese), with the permission of the Nomura Foundation (formerly the Tokyo ClubFoundation for Global Studies.

9

Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

2. Reasons for the weak startYuan-denominated trade started out fairly slow. In interviews of Japanesesubsidiaries in China that we conducted in October 2009, several reasons were given
for this weak start. First was the difficulty in quickly making the transition away fromthe standard approach of denominating trade in foreign currencies. Second, there islittle incentive for the Hong Kong side to bear the currency risk. Third, yuan
settlement entails an administrative cost on both the mainland side and Hong Kongside, including document review and customs declarations. Fourth, there are novehicles for the Hong Kong side to invest yuan.
In addition, some of the pilot enterprises on the initial list did not even apply, butwere chosen based on the recommendation of their local bank. Consequently, it
appears that some Japanese firms were put on the list without their knowledge.
Although some Japanese firms liked the idea of being chosen as a pilot enterprise,
there were apparently others that had reservations, based on concern they would be
subject to pressure from or be obligated by the authorities. It appears that there arealso firms that are worried over how to respond if they are asked to settle trade inyuan by a trading partner in China.
From the banks' perspective, some observers point out that for the local banks, theprofit targets for each branch are difficult to reach, and this reduces their incentive toincur expenses to aggressively go after the yuan business, even though yuan
settlement would help diversify profits in the future.

3. Outlook for growth in the number of pilot enterprises
Plans are apparently to expand the number of pilot enterprises on the mainland.
Unlike the first round of selection, we expect companies that are actually interested in
yuan-settled trade to join the test.
There have been reports of some Japanese firms that are settling trade between
their Hong Kong and mainland subsidiaries in yuan (see Figure 5 again) 2 . One
example of this is Konica Minolta Business Technologies, which uses yuan to settle
payment for copier components sold by its Hong Kong subsidiary to its Guangdong
subsidiary. This can probably be partially explained by the fact that it is easier todecide which side (Hong Kong or the mainland) bears the exchange rate risk when thecompanies are in the same corporate group. It will be interesting to see whether thispattern becomes more common.

2

Yuan accounts opened for overseas participating banks now total 160 accounts (with abalance of RMB690 million) opened by domestic settlement banks and 53 accounts(RMB48.62 billion) opened by the Bank of China (Hong Kong).

Yuan-denominated trade settlement and the internationalization of China’s currency

10IV. Outlook for internationalization of the yuan
1. Yuan internationalizes in stages
1）The debate within China
Although the idea of internationalizing the yuan began with aim of facilitating theuse of the currency in trade settlement, the official opinion of the Chinese governmentis that although there is no established timeline for such internationalization, there is
active debate taking place with China's research institutions.
For example, Wu Nianlu, Vice Chairman and Secretary General of the China
International Finance Society, opined in the Economic Observer dated 1 October 2009that the yuan's internationalization should proceed in steps, starting with localization,then regionalization, and finally internationalization (Figure 7).
The yuan will not be truly internationalized until it is freely convertible and capital
controls are lifted, but until China's domestic money and capital markets are further
developed, it appears that its first step, while domestic restrictions remain in place,will be to expand yuan settlement of trade and investment with the rest of Asia andother important commercial partners.

Figure 7: Internationalization of the yuan

Localization■Use of yuan in cross-border trade

Regionalization■Use of yuan in trade and investment

Internationalization
Source:■Full internationalization requires full yuan
convertibility and the lifting of capital controls

Nomura Institute of Capital Markets Research, based on Wu Nianlu, "Three
Steps to Internationalization," 1 October 2009 edition of the Economic Observer2）Arguments made by those affiliated with the Hong Kong government(1) Yuan internationalization in three stages
While moving forward with yuan-denominated trade, Hong Kong has also been
doing research into the yuan's internationalization. In its May 2009 publication, The
Pilot RMB Trade Settlement Scheme and RMB Internationalization, the Hong Kong
Trade Development Council (HKTDC) outlined the three stages of the

11 Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

internationalization of a currency, including the yuan (Figure 8). The first stage is thepricing and settlement of trade in that currency. The second stage is its use as aninvestment vehicle. The third stage is achieving status as an international reserve
currency.
Figure 8: Three stages of yuan internationalization
First stage:
Use for pricing and settlement of international trade
Second stage:
Use for investment

Third stage:
Use as international reserve currency

Source:Nomura Institute of Capital Markets Research, based on data from HKTDC

The yuan has already reached the first stage, and its use in trade settlement isnaturally increasing its circulation outside of the mainland and gradually making its
use acceptable regionally and globally.
The second stage will have been reached when the yuan gains status as aninternational vehicle for investment. That is conditional on the yuan being backed bysound fundamentals, however, including prudent fiscal and monetary policies, robust
economic growth, a healthy current account balance, and sufficient foreign currency
reserves. The report notes that investors must have a favorable assessment of both the
supply-demand balance and the regulatory framework of China's investment assets,
namely stocks, bonds, and real estate. It also says that the presence of large, maturefinancial markets increases the attractiveness of a currency as an investment vehicle,
and makes it possible to offer a variety of investment choices, efficient and effective
transaction and settlement mechanisms, and an adequate capacity to absorb an influxof foreign capital.
The third stage, becoming an international reserve currency, comes after the firsttwo stages and means that the central banks of other countries hold the currency as areserve currency. Having reached the first two stages is no guarantee of a currency
automatically becoming an international reserve currency, since the international use
of a currency is ultimately determined by market forces.
(2) Requirements for yuan internationalization
The report notes that there are still problems with the yuan meeting the conditions
for entry into the second stage: use as an investment vehicle. Specifically, themainland's financial markets are relatively immature, particularly its debt and derivate

Yuan-denominated trade settlement and the internationalization of China’s currency

12

markets, and stock market participation by nonresident investors is low. The report
therefore argues that mainland financial markets must offer nonresident investors a
broader choice of investments, by developing new financial products and fostering
derivative markets. It also notes that a greater number of nonresident investors mustbe allowed to trade on mainland stock exchanges. Over the near term, in step with thegradual liberalization of mainland financial markets, there is a need to develop yuandenominated investment products for the long term and make the mainland a more
attractive place for nonresident investors' portfolio investments.
If Hong Kong sees growth in the amount of trade settled in yuan and in the size ofits market for yuan-denominated bonds, both financial institutions and non-financial
enterprises should start taking a more favorable view of Hong Kong as a businesslocation. The Hong Kong authorities also appear to have this as a goal. This isapparently part of the Hong Kong government's decision to make Hong Kong an
offshore yuan center, and thereby create differentiation with Shanghai.

2. Comparison with Japan and future outlook
1）The current stage of liberalization of China's foreign exchange and capital
markets is comparable to that of Japan in the early 1970s.
The internationalization of the yuan will require making the yuan convertible andderegulating capital transactions, but as made clear in the aftermath of the latest
global financial crisis, proceeding with liberalization while still maintaining prudent
controls is a difficult policy challenge. As already noted, if problems arise in theprocess of internationalizing the yuan and create turmoil in China's economy, it would
probably inflict considerable damage on the global economy.
Japan's experience in opening and liberalizing its money and capital markets in the
1980s and 1990s during the process of yen internationalization provides a reference inthis regard. Figure 9, which compares the history of currency and capital market
liberalization in Japan and China, shows that although China has gradually liberalized
its foreign exchange and capital transactions, it is now about where Japan was in theearly 1970s. Although coming relatively later in the process, China's allowing of yuan
trade settlement roughly corresponds to Japan's introduction of yen accounts for
nonresidents in 1960. In addition, even those areas that have been liberalized in China
still have caps and require approvals, and thus have yet to be fully liberalized.
Consequently, although China's ongoing process of liberalizing its currency andcapital markets is unlikely to map perfectly with what occurred in Japan's money andcapital markets, it may follow suit. For example, Hong Kong's offshore yuan market
may follow the pattern seen in the 1980s in the euroyen market, which achieved
growth despite having to sidestep domestic regulations.

13 Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

Figure 9: Japan-China comparison of currency and capital market liberalization
Japan
1960
1961

Introduction of yen accounts for nonresidents(Use of yen for settling with overseas firms)

1984

Residents allowed to issue stock overseas
Achieves current account convertibility(Becomes IMF 8 treaty country)
Begins liberalization of inbound portfolio investment
Begins issuance of yen denominated bonds bynonresidents (Samurai bonds)
Begins liberalization of outbound portfolio investment
Nixon shocks,
yen moves to provisional floating exchange rate
regimeAbolished system in which foreign exchange wascentralized
Yen moves to fully floating exchange rates
Tokyo Stock Exchange establishes market for foreign
stocks
Revision of Foreign Exchange and Foreign Trade
Control Act (capital transactions deregulated inprinciple)
Creation of certificates of deposit (deregulation ofinterest rates)
Elimination of the actual demand rule for forward
exchange transactions
Deregulation of yen-denominated loans to overseas
borrowers
Restrictions on yen conversion lifted

1984

Nonresidents issue euroyen bonds

1964
1967
1970
1970
1971
1972
1973
1973
1979
1979
1984
1984

2009
1993
1996
2002
2005
2006
2005

China
Trial use of yuan-denominated settlement of trade between five cities(Shanghai, Guangdong, Shenzhen, Zhuhai, and Dongguan) and Hong
Kong, Macau, and ASEAN countries.
Tsingtao Brewery approved to issue H shares in Hong Kong
Achieves current account convertibility(Becomes an "IMF Article 8" country)
Launches Qualified Foreign Institutional Investor (QFII) program
Nonresidents (IFC and ADB) allowed to issue yuan-denominatedbonds (Panda bonds)
Launches Qualified Domestic Institutional Investor (QDII) program
Reform of yuan exchange system,moves to managed float referencing a basket of currencies

Date of implementation unknown
Date of implementation unknown(Shanghai Securities Exchange now considering establishing aninternational board)(2010)

Date of implementation unknown
Date of implementation unknown
Date of implementation unknown(SAFE and related agencies now considering allowing the policy
banks to make yuan-denominated loans to overseas customers)
Date of implementation unknown
Mainland China-affiliated financial institutions approved for issuance2007
of yuan-denominated bonds in Hong Kong
Date of implementation unknown(undecided)

1986

Establishment of Tokyo Offshore Market (JOM)

1987

Commercial paper introduced
2005
Short-term finance bonds (commercial paper) introduced
Criteria to qualify for issuing corporate bonds
Date of implementation unknown
eliminatedRevision of Foreign Exchange and Foreign Trade
Date of implementation unknown
Control Act (reporting system for capital transactions)

1996
1997

Source: Nomura Institute of Capital Markets Research, based on various data sources

Current moves toward the international opening of China's domestic issuancemarket include (1) the establishment of an international board on the Shanghai Stock
Exchange (for listing the A shares of foreign firms), (2) the repatriation of red-chip
firms (affiliates of Chinese firms established in Hong Kong) to mainland exchanges,(3) changes to the issuance terms of Panda bonds (the equivalent of Samurai bonds),(4) the domestic issuance of finance bonds by auto sales financing companies(including foreign capitalized), and (5) the domestic issuance of finance bonds by the
Chinese subsidiaries of foreign capitalized banks. All of these developments, with the
exception of (2), bring to mind Japan's previous experience with financial
liberalization. We think it unlikely that financial service providers overseas are goingto overlook the new business opportunities associated with this financial liberalizationin China.

2）The outlook for yuan-denominated trade settlement
Just how far does China plan to go in internationalizing its currency? We think the
Chinese government has plans to gradually expand its existing framework for yuaninternationalization, which currently consists of using the yuan for settling trade,Yuan-denominated trade settlement and the internationalization of China’s currency

14

currency swaps, and bond issuance in Hong Kong. Of these, we envision thefollowing scenario for the expansion of yuan trade settlement.

(1) Broadening the regions and products eligible for yuan trade settlement
There is movement underway to increase the number of pilot regions for yuan
trade settlement, both inside and outside of China. The Opinions Regarding Further
Implementation of the Strategy for Revitalization of Old Industrial Bases in the
Northeast and Elsewhere, approved by the State Council on 17 August 2009, allows
for the testing of yuan-denominated trade settlement in the Northeastern regions of
Liaoning, Jilin, Heilongjiang, and the Inner Mongolia autonomous region (Figure 2).
The Special Test Projects for Comprehensive Financial Reform and Innovation in the
Tianjin New Coastal District proposed by the National Development and Reform
Commission was approved by the State Council on 26 October 2009. It includes
research of offshore financial services in Tianjin as well as a trial of both trade
settlement and offshore investment denominated in yuan.
As part of China's effort to expand the number of countries and regions with which
it settles trade in yuan, on 13 October 2009, Chinese Premier Wen Jiabo and RussianPrime Minister Vladimir Putin announced an agreement, as part of the 14th SinoRussian Joint Statement, to deepen cooperation in the finance, investment, andinsurance sectors, and to research further settlement in their respective currencies.
Some Sino-Russian cross-border trade is already being settled de facto in yuan, but
the agreement formally begins the consideration of mechanisms to incorporate thissettlement into the banking system. In addition, the joint statement adopted upon theclose of the China-ASEAN Financial Cooperation and Development Leadership
Forum on 21 October 2009 agreed to promote intra-regional settlement models,
remove unnecessary regulatory barriers, and help exporters on both sides reduce
operating costs. The PBC and the Monetary Authority of Macao signed a
supplementary memorandum on oversight cooperation on 14 December 2009 topromote yuan trade settlement.
Outside of Asia, China is studying with Brazil the possibility of settling commodity
and other trade in their respective currencies. For its part, Brazil is also considering
the overseas issuance of government bonds denominated in its currency, the real
(BRL)3, [4] and this would probably provide China with a way to invest the real it hasreceived in trade.
The people we interviewed in China pointed out that internationalization of theyuan would require that China supply liquidity overseas by running a trade deficit ingoods and services with other countries and regions. For this to happen, China would
have to move away from its current export-driven model for economic growth andstart promoting growth in domestic demand, especially private-sector consumption.
Although that may be true over the medium to long term, over the near term there are
already countries and regions with which China runs a trade surplus (Figure 10) ,3

Nihon Keizai Shimbun, 11 November 2009 edition.

15 Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1

some of which are the same trading partners noted above, specifically Asian countries(Taiwan, Korea, Japan, Malaysia, Philippines, and Thailand) and resource-richcountries (Australia, Iran, Brazil, and Argentina). An important question is when and
how China will start using yuan to settle trade with these countries and regions.
Figure 10: China's trade balance(US$ millions)
Country/region

2008

2007

2006

(US$ millions)

Comments

Sector2006

1
2

TaiwanKorea▲ 77,445▲ 38,270▲ 77,506▲ 47,916▲ 66,401▲ 45,260 Has currency swap agreement with China

TextilesMachinery and electronics products

112,41785,957

3

Japan▲ 34,631▲ 31,787▲ 24,038

Other products

28,3494
5

Saudi Arabia
Australia▲ 20,290▲ 14,040▲ 9,731▲ 7,761▲ 10,032 Natural resources and energy▲ 5,568 Natural resources and energy

MetalsFootwear and headwear

25,52425,478

6
7

IranBrazil▲ 11,534▲ 10,857▲ 6,041▲ 6,965▲ 5,467 Natural resources and energy▲ 5,527 Natural resources and energy

Ceramics & glass
Foods

13,8789,731

8Malaysia▲ 10,748▲ 11,036▲ 10,037 Has currency swap agreement with China

Leather and fur

9,106

9 Philippines
10 Thailand▲ 10,420▲ 10,116▲ 15,623▲ 10,674▲ 11,938 ASEAN▲ 8,198 ASEAN

Transport equipment
Live animals and animal products

8,699
2,460

11 Argentina▲ 4,332▲ 2,747▲ 1,693 Has currency swap agreement with China

Services

47
119

▲ 129
92

▲ 116 ASEAN
119 ASEAN

Wood products
Vegetable products▲ 1,583▲ 5,608

1,056
1,335

830
1,321

663 ASEAN
955 ASEAN

Plastic & rubber
Chemical products▲ 16,637▲ 18,433▲ 102,146

12 Brunei
13 Laos
14 Cambodia
15 Myanmar

283

16 Macao

2,295

2,362

1,925

Mineral products

17 Indonesia
18 Canada

2,823
9,013

229
8,388

▲ 157 Has currency swap agreement with China
7,853 Natural resources and energy

Note:1.Sectors based on HS codes.

19 Russia

9,228

8,854

20 Vietnam
21 India

10,797
11,175

8,691
9,378

4,982 ASEAN
4,119

3.Chemical products include fertilizers, organic
chemicals, and pharmaceuticals.

22 Singapore
23 United Arab Emirates

12,23318,937

12,15914,0305,513 ASEAN
8,616 Natural resources and energy

4.Mineral products include lime, cement, slag,
and petroleum and other fossil fuels.

24 EU

160,072

134,189

91,57525 US
26 Hong Kong

170,829
177,826

162,901
171,465

144,293
144,640 Has currency swap agreement with China▲ 1,709 Natural resources and energy

2.Foods refers to processed foods.

Source: Nomura Institute of Capital Markets Research,based on CEIC

Source: Nomura Institute of Capital Markets Research, based on CEIC

(2) Growth in yuan currency swaps
There has also been growth in yuan currency swaps. The above-mentioned jointstatement adopted by the 2009 China-ASEAN Financial Cooperation andDevelopment Leadership Forum called for growth in currency swaps within theregion, although it did not specifically call for yuan swaps. In addition, China isalready in talks with Thailand and, outside of Asia, with Brazil, regarding possible
currency swap agreements.
Furthermore, in an article in Yanjiu Cankao dated 9 March 2009 entitled (Reformof the international currency regime: continue with uni-polar or transition to multipolar?), Wu Xiaoqiu of the Financial and Securities Institute of Renmin University of
China states that the Chinese government has already signed bilateral agreements witheight bordering countries, including Russia, Mongolia, Myanmar, and Vietnam,
mutually authorizing settlement in their respective currencies. PBC Vice Governor Su
Ning, who attended the China-ASEAN Leadership Forum, had already announced
bilateral settlement cooperation agreements with the central banks of Vietnam andLaos following that forum. If currency swap agreements between the central banks areadded to these settlement cooperation agreements, it would probably provide more
support to yuan trade settlement.

Yuan-denominated trade settlement and the internationalization of China’s currency

16

Although not much trade is being settled in yuan at this time, use of the yuan for
trade could eventually raise the profile of China's capital markets, just as other major
events that were initially under the radar have done in the past, such as the creation of
A shares on China stock exchanges and the start of reforms of non-tradable shares.
Trends in the use of yuan to settle trade and moves toward the internationalization of
the yuan continue to merit close watching.

17 Nomura Journal of Capital Markets Spring 2010 Vol.2 No.1